Technological Change, Financial Innovation, and Financial Regulation: The Challenges for Public Policy

The two technologies that form the heart of the financial services industry—data processing and telecommunications—have experienced rapid improvement and innovation in the United States in the past few decades. In the heavily regulated financial services industry, technological innovation and improvement may pose significant problems and challenges, both for the industry itself and for the government regulators and public policy makers. In this paper, the author provides an overview of the interactions between financial innovation and regulation. The author first makes a distinction among types of financial services firms that is essential to an understanding of financial services regulation. Institutions such as banks and insurance companies that hold financial assets and issue liabilities are known as financial intermediaries. A company that extends trade credit to its customers acts as a lender and is therefore a financial intermediary. The second category of financial services firms comprises firms like stockbrokers and investment bankers who facilitate financial transactions between primary issuers of financial liabilities and the investors who purchase these instruments. These firms are known as financial facilitators. Although there are firms that act both as intermediaries and facilitators, the distinction is an important one in understanding the interaction between technological innovation and financial regulation in the U.S. The author next turns to an analysis of the four major underlying causes of the recent technological changes in financial services. First, data processing and telecommunications have become both more powerful and inexpensive, allowing improved data collection, risk assessment and wider geographical reach for products. Second, less restrictive and protectionist laws and regulations have paved the way for greater competition and allowed outside innovators to enter the financial services market. Third, the shift from a relatively stable to a risky economy beginning in the 1970s created a demand for futures and options that would protect investors from risk. Finally, as a reaction to a strict regulatory environment, financial institutions developed innovative ways to circumvent cumbersome regulations. One of these developments, for example, was the money market mutual fund. Recent easing of restrictions has also encouraged financial innovation. The author turns to a detailed discussion of financial regulation, explaining the distinctions between the three major categories of: 1) economic regulation; 2) health-safety-environment regulation and; 3) information regulation. He then covers the specifics of regulations affecting: 1) banking; 2) securities and related instruments; 3) insurance; 4) pension funds; 5) mortgage conduits and; 6) finance companies and leasing companies. He then reaches the following conclusions based on his evaluation of the environment within which financial regulation operates: 1) the widespread nature of financial regulation is not accidental; 2) of the three categories enumerated above, information regulation extends most widely across the financial sector; 3) safety regulation applies most directly and strongly to those financial intermediaries who have the most widespread liabilities and; 4) economic regulation applies most extensively to banks and other depositories. He next explores the interaction between innovation and regulation and concludes that regulation has both negative and positive effects on innovation, this determination particularly depending on the critic's perspective on the regulations. The main effects of innovation on regulation now and in the future should involve the following issues: 1) more federal centralization of regulation, and less state regulation; 2) more international markets for financial products; 3) greater efficiency of financial markets due to increased competition; 4) development of regulations for new financial instruments; 5) differential regulatory treatment of risky financial instruments and; 6) stored value cards and smart cards and other electronic based innovations; 7) new privacy policies resulting from increased gathering of personal information from electronics-based instruments; 8) increased flows of funds through EFT systems and; 9) new interactions between computer software and hardware as well as with outside institutions as financial services transactions depend more on electronics-based instruments. The author concludes that a major task of public policy must be to ensure that financial regulation does not stifle innovation while it responds appropriately to challenges posed. This paper was presented at the Financial Institutions Center's conference on Performance of Financial Institutions, May 8-10, 1997.

The role of pension funds as institutional investors in emerging markets

In recent years, a growing number of Emerging Market Economies, as well as most advanced countries, have witnessed growth of pension funds as institutional investors. This has often occurred in the wake of pension reform shifting retirement income provision from pay-as-you-go to funding. The ongoing ageing of the population and financing difficulties of pay-as-you-go systems suggests that such reforms will become yet more common in the future. Accordingly, it is important to analyse the impact of institutional investment on the economy. In this context, our aim is to address the role of pension funds as institutional investors in financial development, and the wider effects of such financial development on economic performance. We note inter alia some of the ways in which the behaviour and impact of institutional investors might differ in emerging market economies from advanced countries as well as policy issues

Effects of foreign acquisitions on financial constraints, productivity and investment in R&D of target firms in China

The file attached to this record is the author's final peer reviewed version. The Publisher's final version can be found by following the DOI link.This paper examines whether foreign acquisitions lessen financial constraints, improve investment in research & development (R&D) and productivity of the target firms in China based on a sample of 914 cross-border mergers and acquisitions (CBM&A) over the period of 1994-2011. Using investment to cash-flow sensitivity to measure financial constraints, we find that foreign acquisitions in China are associated with a reduction of target firms’ financial constraints, irrespective of the ownership type of the target firm. However, the extent of financial constraint reduction is pronounced for non-SOEs compared to state-owned enterprises (SOEs). This study also provides evidence that foreign acquisitions improve Chinese target firms’ productivity and investment in R&D

Governance of securities clearing and settlement systems

In the context of securities clearing and settlement systems, the nature of governance arrangements acquires a dimension that goes beyond their traditional function in corporate law. They constitute a tool for regulators and central banks to achieve their respective policy goals relating to market operation, market integrity, and systemic stability. In the light of the analysis of this paper, and pending a further evolution in the regulation of securities clearing and settlement in the Community, the following conclusions can be drawn. Whatever the model of corporate governance used in a jurisdiction, securities clearing and settlement systems should adopt and ensure effective implementation of the highest corporate governance standards or best practices adopted or recommended for companies in the jurisdiction in which it operates as such standards or practices evolve over time. Generally, this would imply that securities clearing and settlement systems at minimum should adopt and implement the best practices recommended for listed companies. Additionally, a securities clearing or settlement system should adopt corporate governance mechanisms adequate to address the interests of users and the public in the operation of the system. Such mechanisms should be organized so that the criteria followed to select participants on the board or on specialized committees are established ex ante. Board members should also take into account the interests of users and the public in board decisions, in particular, those relating to qualifications for system access, fair pricing, the integrity of the risk management system, innovation and efficiency, and the achievement of the policy objectives of competent authorities. Securities clearing and settlement systems should make adequate disclosures regarding their corporate governance arrangements so that users and the public can ascertain the manner in which conflicts of interest among owners, the board, users and the public interest are prevented, resolved or mitigated. Corporate governance arrangements of securities clearing and settlement systems should be the subject of adequate regulation and oversight to ensure that services are provided at fair prices to users under fair and equitable conditions of access; that the risk management programs of system operators are effective; that risk management decisions are not affected by considerations extraneous to the risk management function; and that, to the maximum extent possible, functional service providers compete in equivalent conditions of competition. Looking forward, the adoption of a harmonized regulatory regime for securities clearing and settlement systems should be considered to complete the internal market within the Community and to better achieve the policy goals identified in this paper relating to the governance of those systems.clearing, settlement, governance, risk management, oversight.

The corporate managers and stockholders relationship: the moral hazard issue, case of Moroccan listed companies

This paper deals with the moral hazard problem associated with the behavior of corporate managers. The stockholders (shareholders) cannot control ex ante the managers, because the latter’s action is unobservable to the former, and the stockholders cannot oblige the managers to choose an action which is effective and benefit both parties. The stockholders may not modify the impact of action taken by managers if and only if they decide to condition the action payment to the final observable income. In the specific context of emerging markets listed companies in where the level of opacity and the inefficiency to monitor are very high, the revelation principle does not play correctly. Therefore, it is not interesting to the Agent to show his true type. In this Paper we will specifically deal with this type of problem within the framework of companies listed in the Casablanca Stock Exchange. Our approach consists to show the moral hazard issue existing between two parties: the stockholders (i.e., uninformed “Principal”) and the manager namely the Chief Executive Officer (i.e., informed “Agent”).Asymmetrical Information; Moral Hazard; Non-fulfilment of Contract; Governance of Listed Companies; Collusion; Cooperative Game; Stockholders; Corporate Managers; Casablanca Stock Exchange.

Corporate Governance and Control

Corporate governance is concerned with the resolution of collective action problems among dispersed investors and the reconciliation of conflicts of interest between various corporate claimholders. In this survey we review the theoretical and empirical research on the main mechanisms of corporate control, discuss the main legal and regulatory institutions in different countries, and examine the comparative corporate governance literature. A fundamental dilemma of corporate governance emerges from this overview: regulation of large shareholder intervention may provide better protection to small shareholders; but such regulations may increase managerial discretion and scope for abuse.

The Case for Mandatory Ownership Disclosure

The use of equity derivatives to conceal economic ownership of shares (“hidden ownership”) is increasingly drawing attention from the financial community, as is the exercise of voting power without corresponding economic interest (“empty voting”). Market participants and commentators have called for expansion of ownership disclosure rules, and policymakers on both sides of the Atlantic are now contemplating how to respond. Yet, in order to design appropriate responses it is key to understand why we have ownership disclosure rules in the first place. This understanding currently appears to be lacking, which may explain why we observe divergent approaches between countries. The case for mandatory ownership disclosure has also received remarkably little attention in the literature, which has focused almost exclusively on mandatory issuer disclosure. Perhaps this is because most people assume that ownership disclosure is a good thing. But why is such information important, and to whom? This paper aims to answer these fundamental questions, using the European disclosure regime as an example. First, the paper identifies two main objectives of ownership disclosure: improving market efficiency and corporate governance. Next, the paper explores the various mechanisms through which ownership disclosure performs these tasks. This sets the stage for an analysis of hidden ownership and empty voting that demonstrates why these phenomena are so problematic.ownership disclosure; market efficiency; corporate governance; monitoring; hidden ownership; empty voting; hedge fund activism

Institutional Technology and the Chains of Trust: Capital Markets and Privatization in Russia and the Czech Republic

The introduction of mass privatization policies in Russia and the Czech Republic depended on the creation of impersonal capital markets to finance the needs of privatized companies and to provide a secondary market for the trading of securities. Yet, mass privatization created the contradictory conditions of generating millions of poorly informed shareholders, with no efficient markets for the sale of the shares. The absence of financial markets created systematic pressures to move assets by illegal or non-transparent means to users who value them. Privatization created the incentives to destroy the financial markets critical to its success. A comparative case analysis of post-privatization market formation in both these countries demonstrates that the functional necessity for these markets does not engender their own creation. In the absence of institutional mechanisms of state regulation and trust, markets become arenas for political contests and economic manipulation. The irony of these policies is that a principal lesson has been that market reforms cannot create viable markets, only institutional formation can.http://deepblue.lib.umich.edu/bitstream/2027.42/39719/3/wp335.pd